QUALSTAR CORP - Quarter Report: 2002 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission file number 000-30083

QUALSTAR CORPORATION

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of  1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

The total shares of common stock without par value outstanding at November 11, 2002 is 12,656,101.

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PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

QUALSTAR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 AND SEPTEMBER 30, 2002
(in thousands)

See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
(in thousands, except per share amounts)
(UNAUDITED)

See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
(in thousands)
(UNAUDITED)

See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
THREE MONTHS ENDED SEPTEMBER 30, 2002
(in thousands)
(UNAUDITED)

See the accompanying notes to these condensed consolidated financial statements.

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QUALSTAR CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(in thousands, except per share amounts)
(UNAUDITED)

NOTE 1.  BASIS OF PRESENTATION

                    The accompanying condensed consolidated financial statements are unaudited, except for the balance sheet at June 30, 2002 which is derived from our audited financial statements, and should be read in conjunction with the consolidated financial statements and related notes included in Qualstar Corporation’s (“Qualstar,” “us,” “we,” or “our”) Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on September 30, 2002.  In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting primarily of normal recurring items, which are necessary for the fair presentation of Qualstar’s consolidated financial position as of September 30, 2002, consolidated results of operations for the three months ended September 30, 2001 and 2002, and consolidated cash flows for the three months ended September 30, 2001 and 2002.  Operating results for the three month period ended September 30, 2002 are not necessarily indicative of results to be expected for a full year.

NOTE 2.  EARNINGS PER SHARE

                    The following table sets forth the computation of basic and diluted net income per share for the three months ended September 30, 2001 and 2002:

NOTE 3.  MARKETABLE SECURITIES

                    Marketable securities consist primarily of high-quality corporate, federal and state government securities.  These securities are classified in one of three categories:  trading, available-for-sale, or held-to-maturity.  Trading securities are bought and held principally for the purpose of selling them in the near term.  Held-to-maturity securities are those securities which the Company has the ability and intent to hold until maturity.  All other securities not included in trading or held-to-maturity are classified as available-for-sale.  All of the Company’s marketable securities were classified as available-for-sale at June 30, 2002 and September 30, 2002.

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                    Available-for-sale securities are recorded at market value.  Unrealized holding gains and losses, net of the related income tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.  Dividend and interest income are recognized when earned.  Realized gains and losses for securities classified as available-for-sale are included in earnings when the underlying securities are sold and are derived using the specific identification method for determining the cost of securities sold.  

NOTE 4.  INVENTORIES

                    Inventories are stated at the lower of cost (first-in, first-out basis) or market.  Inventory is comprised as follows:

NOTE 5.  COMPREHENSIVE INCOME

                    For the three months ended September 30, 2001 and 2002, comprehensive income amounted to approximately $1.1 million and $0.5 million, respectively.  The difference between net income and comprehensive income relates to the changes in the unrealized losses or gains the Company recorded for its available-for-sale securities.

NOTE 6.  BUSINESS ACQUISITIONS 

                    On July 11, 2002, the Company acquired the assets and intellectual properties of N2Power, Incorporated (N2Power), a privately held company which designs and produces small and efficient open-frame switching power supplies.  The consideration for this acquisition was $250,000 plus acquisition expenses of $38,000.  The purchase price was primarily allocated to a patent which will be amortized over 5 years. The accompanying consolidated financial statements include the operations of N2Power from the date of acquisition.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

                    This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements inherently are subject to risks and uncertainties, some of which we cannot predict or quantify.  Our actual results may differ materially from the results projected in the forward-looking statements.  Factors that might cause such a difference, include, but are not limited to, those discussed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2002 in “ITEM 1 Business,” including the section therein entitled “Risk Factors,” and in ITEM 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  You generally can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “may,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” or the negative thereof or variations thereon or similar terminology.  We disclaim any obligation to update or revise these forward-looking statements to reflect the occurrence of events or circumstances in the future.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001.

                    NET REVENUES. Revenues are recognized upon shipment of the product to the customer, less estimated returns, for which provision is made at the time of sale.

Net revenues for the three months ended September 30, 2002 were $8.8 million, consistent with net revenues of $8.8 million for the three months ended September 30, 2001.  The selling prices of our tape libraries have remained relatively stable during the quarter ended September 30, 2002.  The selling prices of tape media has decreased slightly since the first quarter of fiscal 2001, whereas the selling prices of tape drives have had an overall increase.  The decrease in selling prices of tape media is primarily due to decreases in our cost to purchase media, which we pass through to our customers.  The increase in selling prices of tape drives is primarily due to the introduction of new releases of existing tape drive technology such as AIT-3 and SDLT 320 which were not yet available during the first quarter of fiscal 2002.  We do not anticipate significant changes in the selling prices of our tape libraries during the second quarter of fiscal 2003.

                    GROSS PROFIT. Gross profit was $3.2 million or 36.1% of net revenues for the three months ended September 30, 2002 compared to $3.3 million or 37.9% for the three months ended September 30, 2001, representing a decrease of 4.6%.  Our gross margin is partially a function of the mix of products sold.  Generally, tape libraries and drives have higher gross profit margins as a percentage of sales than do tape media.  The decrease in our gross profit margin as a percentage of net revenues is primarily the result of higher sales of tape media. 

                    RESEARCH AND DEVELOPMENT. Research and development expenses consist of engineering salaries, benefits, purchased parts and supplies used in development activities.  Research and development expenses for the three months ended September 30, 2002 were $0.8 million or 9.5% of revenues as compared to $0.5 million and 5.3% of revenues for the three months ended September 30, 2001.  Our higher research and development spending reflects our establishment of an Advanced Development Group in Boulder, Colorado.  This group has been established to broaden our overall product line with new and innovative tape libraries.  We expect research and development expenses to remain steady or slightly increase during the next quarter.

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                    SALES AND MARKETING. Sales and marketing expenses consist primarily of employee salaries and benefits, sales commissions, trade show costs, advertising, technical support and travel related expenses.  Sales and marketing expenses for the three months ended September 30, 2002 were $0.9 million, an increase of $0.4 million compared to the three months ended September 30, 2001.  Sales and marketing expenses as a percentage of net revenues were 9.7% for the three months ended September 30, 2002 as compared with 5.7% for the three months ended September 30, 2001.  The increase in sales and marketing expenses is attributable primarily to an overall reduction of marketing development funds and rebates from our key suppliers.  Expenditures on salaries, commissions, trade shows, and advertising have remained stable.  We anticipate sales and marketing expenses will remain stable as a percentage of net revenues for the second quarter of fiscal year 2003.

                    GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of employee salaries and benefits, deferred compensation related to equity incentives, provisions for doubtful accounts and returns and professional service fees. General and administrative expenses for the three months ended September 30, 2002 were $0.9 million, or 10.2% of net revenues, a small increase compared with $0.8 million, or 9.5% of net revenues, for the three months ended September 30, 2001.  The increase in general and administrative expenses is primarily due to an overall increase in personnel costs associated with administration of the Company.  We do not anticipate that general and administrative expenses will significantly increase in the second quarter of fiscal 2003.

                    PROVISION FOR INCOME TAXES. The provision for income taxes was $0.4 million or 42.7% of pre-tax income, for the three months ended September 30, 2002, compared to $0.7 million, or 35.9% of pre-tax income, for the three months ended September 30, 2001.  The increase in the provision for income taxes as a percentage of pre-tax income is primarily due to the increased impact of expenses included in the financial statements which are not deductible for tax purposes.

LIQUIDITY AND CAPITAL RESOURCES

                    Historically, we have funded our capital requirements with cash flows from operations.  Cash flows provided by operating activities were $3.2 million and $0.5 million for the first three months of fiscal 2003 and 2002, respectively. For the three months ended September 30, 2002, operating cash was primarily provided by collection of accounts receivables and reductions in inventory levels.  For the three months ended September 30, 2001, operating cash was primarily provided by net income. 

                    Cash provided by investing activities was $1.8 million during the first three months of fiscal year 2003.  The sale of marketable securities, offset partially by purchases of fixed assets and the assets of N2Power, Inc., was the primary reason for the increase in cash from investing activities.  During the first three months of fiscal year 2002, the Company used $7.4 million of cash in investing activities.  This use was attributable to the purchase of marketable securities and fixed assets.

                    There was no significant cash used or provided by financing activities during the three month period ended September 30, 2002 or the three month period ended September 30, 2001.

             We believe our existing cash and cash equivalents, plus anticipated cash flows from operating activities, will be sufficient to fund our working capital and capital expenditure needs for at least the next 12 months.  We may utilize cash to invest in businesses, products or technologies we believe are strategic.  We regularly evaluate other companies and technologies for possible investment by us.  In addition, we have made and expect to make investments in companies with whom we have identified potential synergies.  However, we have no present commitments or agreements with respect to any material acquisition of other businesses or technologies.

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ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk

                    We develop products in the United States and sell them worldwide.  As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.  Since all sales are currently made in U.S. dollars, a strengthening of the U.S. dollar could make our products less competitive in foreign markets.  Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments.  We have no outstanding debt nor do we utilize derivative financial instruments.  Therefore, no quantitative tabular disclosures are required.

ITEM 4.   Controls and Procedures

                    Subsequent to September 30, 2002, the Company’s principal financial officer, Matthew Natalizio, resigned as an employee of the Company and the Company has hired Frederic T. Boyer as the new principal financial officer.  Mr. Boyer will not fully to assume his duties as principal financial officer until sometime after the filing of this report.  During the interim period, our principal executive officer, William J. Gervais, is also the acting principal financial officer. 

                    The Company’s principal executive officer and its principal financial officer have concluded that the Company’s disclosure controls and procedures are adequate and effective for the purposes set forth in Exchange Act Rule 13a-14(c).  This conclusion was based on his evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)) as of a date within 90 days prior to the filing of this Quarterly Report on Form 10-Q.

                    There were no significant changes in the Company’s internal controls or in other factors since the date of evaluation that could significantly affect the Company’s internal controls.

PART II -  OTHER INFORMATION

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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Certification of Principal Executive Officer

Date:      November 14, 2002

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Certification of Principal Financial Officer

Date:      November 14, 2002

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EXHIBIT INDEX